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Obama Plan to Cap Health Insurance Overhead Flawed

Health insurance watchdogs in Oregon say the way regulators and the industry have analyzed administrative costs for decades are wrong. Will Obama and Congress listen?

As part of reining in health insurance costs, President Barack Obama and leading reform advocates in Congress want to limit the amount of money insurers spend on administrative expenses.

There's just one problem: The formula Obama and others want to use to determine an appropriate level of administrative overhead allows health insurers to directly benefit as premiums rise — a very perverse incentive to lower costs. Put another way, as long as premiums increase at a rate higher than general inflation, Obama's plan would allow health insurers to continue reaping greater profits while spending more on salaries, marketing and office buildings with each passing year.

The issue can be arcane, but it's crucial to understanding a major health insurance industry justification for setting administrative costs: the "medical-loss ratio," the percent of premium dollars insurers spend on medical expenses. According to regulators in Oregon and some in other parts of the country, this method is flawed and should be re-examined.

Oregon lawmakers this year passed what's likely to become the country's most progressive look at regulating health insurance premiums, and perhaps the U.S. Congress should take a look.

Oregon's Law
Starting next year, Oregon insurers will have to submit detailed reports on administrative costs, down to how much they spend on office furniture. More importantly, through rule-making still in progress, Teresa Miller, administrator of the Oregon Insurance Division, wants to prohibit administrative costs from exceeding increases for that year in the Consumer Price Index, which rose on average 2.8 percent annually over the past eight years.

Insurers opposed the effort when the bill came before lawmakers. Mike Becker, a lobbyist for Regence Blue Cross Blue Shield of Oregon, the state's largest commercial insurer, testified at a legislative committee hearing earlier this year.

"This is not about health care reform," Becker said. "This is about untested experiments. Nowhere in the country has this degree of rate regulation been applied."

Now that the law has passed, insurers continue to resist state regulators through the rule-making process. "I've been disappointed that the insurance industry really seems to be digging in to fight transparency at any turn," said state Rep. Chip Shields, D-North Portland, who leads the effort among state lawmakers on rate regulation. "I'm very concerned that the political pressure from the insurance companies will be immense."

Currently, as in most states, administrative costs are allowed to increase at the same staggering rate as premiums, which have gone up more than 10 percent annually for the past decade not because there are more visits to the hospital, but because those visits have become on average more expensive.

The actual rate of medical inflation, meanwhile, remains a fuzzy number. Medical care inflation over the past decade rose on average more than 4 percent annually, according to the Bureau of Labor Statistics, but that figure is routinely rejected as well below the actual rate.

"Why would administrative costs stick to premiums? They shouldn't," Miller asked. "The cost-drivers just aren't the same. It doesn't make any sense to attach administrative expenses to the rest of the rate filing that's going to go up at medical inflation rates."

Miller knew she had a landmark piece of legislation on her hands, so she jumped at the opportunity to share it with her colleagues in other states. She took pages of the health care reform bill that dealt with administrative costs to a June conference of the National Association of Insurance Commissioners.

"I changed my airline ticket for the conference," Miller said. "We've been talking about this for a couple of years now. I said, 'Here's the legislation we just passed.' And they were very excited."

Duplicating Elsewhere
State laws in most cases prevent regulators from dissecting administrative costs in such a detailed fashion, said Steven Ostlund, an actuary with the Alabama Department of Insurance who chairs the task force where Miller presented the legislation.

"To my knowledge, Oregon is the first to address this as directly as they did," Ostlund said.

The group of actuaries at the NAIC listened intently to Miller's presentation and made copies of Oregon's new law in hopes of inspiring similar action in their own states. Whether Congress will do the same appears unlikely based on the draft bills that passed out of committees so far.

In discussing health insurance at town hall meetings, Obama endorsed a concept in HR 3200 that dictates insurers spend no less than 85 percent of every premium dollar on medical expenses. That percentage represents an insurers' medical-loss ratio. Insurers also keep target-loss ratios, which dictate spending and help plan for the following year's rate adjustments.

Commercial insurers typically maintain loss ratios between 75 and 90 percent. Put another way, 75 to 90 cents of every premium dollar goes toward actual health care costs, mostly doctors, hospitals and prescription drugs. The remainder goes to insurer profits and administrative costs, such as salaries and marketing.

A high loss ratio suggests insurers are keeping administrative expenses at a reasonable rate — after all, they're only retaining 15 cents out of each dollar spent on insurance premiums.

But while the percentage seems reasonable, the total amount insurers reap actually keeps pace with the skyrocketing costs families and individuals pay for health insurance premiums. It's not uncommon in recent years for premiums to increase more than 20 percent, even more than 40 percent in the case of some individuals and small group plans.

Most of that astronomical increase comes from the exploding costs of existing services, hospital charges, new technologies and pharmaceuticals — not because it suddenly costs 20 or 40 percent more to administer higher bills.

Therefore, even if an insurers' medical-loss ratio remains the same from one year to the next, if administrative costs increase in line with the Consumer Price Index, say 3 percent, and premiums increase by any percentage greater than that, insurers are making a lot more money.

"If in fact the reason your rates are going up is an increase in health care costs, and the administrative costs just continue to balloon along with it, the administrative costs at some point have become extraordinarily overpriced," said Ellen Pinney, founder of Oregon Health Action Campaign, an advocacy group.

Unrelated Increase
"Overpriced," of course, is in the eye of the beholder.

Two good reasons administrative costs might rise include an increase in enrollment, if the health plan has to deal with more members, or an increase in utilization of services.

But neither appears to have happened in recent years.

Based on U.S. Census data, the number of Americans with private health insurance has increased less than 1 percent from 1999 to 2007.

Considering hospital services, the leading driver of health care costs, utilization increased about 1.2 percent annually, based on Kaiser Family Foundation statistics detailed at

"Rising claim costs — not administrative expenses — drive premiums," said Samantha Meese, spokeswoman for Regence Blue Cross Blue Shield of Oregon. Meese cited the company's low administrative costs in relation to premiums (8.5 percent last year) to demonstrate its low overhead.

America's Health Insurance Plans, a national industry trade group, did not respond to a request for comment on this article.

It's not the number of cases that has increased, said Bernard Friedman, a health care economist with the federal Agency for Health Care Quality and Research. It's the cost per case.

"In some [areas of medicine], the numbers of cases are increasing. In other areas, the number of cases are falling right now, but the cost per case could be increasing if, for instance, it's only the severely ill who can't benefit from the modern medication who still have to come to the hospital [for life-saving treatment]."

After hospitals, the two next biggest medical cost-drivers are pharmaceutical drugs and physician services. "Those are two big components that are missing in our data sets. Those are hard numbers to get," said Herb Wong, a senior economist with AHRQ.

"Although folks use Medicare information, that's probably not appropriate [for private insurers] because the populations are much different in terms of behavior," Wong said. Medicare beneficiaries are older and tend to see doctors and take more prescription drugs than younger patients insured by commercial health plans.

A far better way to judge administrative costs might be to divide them per member per month, which a recent report commissioned by the Blue Cross and Blue Shield Association does to compare commercial plans' administrative costs to that of Medicare.

The report, conducted by the Sherlock Company, (see "Resources" at right to see the full report) uses a per member per month standard to argue that commercial insurers have lower overhead costs than Medicare, which generally maintains 3 to 6 percent administrative costs in relation to premiums. It argues that private plans spend on average $12.51 per member per month in the individual and small group markets compared to $13.19 the government spends under traditional Medicare.

So if it works for insurers in arguing their own case, why not apply the same logic to overall health insurance reform as well?

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